Market Commentary
Apparent progress toward resolving the conflict in the Middle East drove crude oil and broader energy prices lower during June. Inflation readings have begun to moderate, although the geopolitical outlook remains highly uncertain.
Recent corporate earnings commentary suggests that consumers in the U.S. and Canada have reduced discretionary spending to absorb higher gasoline and household energy costs.
At the ECB Forum on Central Banking in Sintra, Portugal, Federal Reserve Chair Kevin Warsh reiterated that artificial intelligence is expected to raise productivity and exert disinflationary pressure, tempering market expectations for a potential rate increase later this year. He also highlighted the Federal Reserve’s newly established task forces as supplementary inputs to conventional economic data. Meanwhile, the U.S. labour market remains in a low-hire, low-fire environment amid AI-related disruption and ongoing tariff uncertainty.
The Canadian economy remains under pressure. April real GDP increased 0.5%, driven largely by higher energy prices and related gains in extraction and transportation activity. With energy prices subsequently declining, some reversal is likely in the coming months, which would be more consistent with the contractions recorded in Q4 2025 and Q1 2026. Against a backdrop of trade uncertainty, the Bank of Canada has guided toward an unchanged policy rate this year. This stance appears increasingly restrictive relative to the weakening growth outlook.
The yield on the Government of Canada long bond was broadly unchanged in June at 3.78%, while the two-year yield declined four basis points to 2.74%.
Over the second quarter, the Canadian yield curve was broadly unchanged. The two-year/30-year spread ended the period at 1.10%, leaving scope for further flattening as economic activity weakens. The Canadian long bond outperformed its U.S. counterpart by 0.10%, with the spread widening to -1.12%. The Fund’s Canadian long-bond exposure therefore remains attractive both relative to shorter maturities domestically and compared with U.S. long-duration government bonds.
During Q2, the U.S. dollar appreciated from approximately C$1.36 to C$1.42. The Fund’s actively managed long U.S. dollar exposure contributed positively; however, activity was reduced late in the quarter as USD/CAD reached materially overbought levels.
Fund Performance and Positioning
The Fund remains positioned for a weaker Canadian economic backdrop through exposure to 30-year Government of Canada bonds. These holdings are actively traded to improve the portfolio’s average entry cost. Duration1 was modestly reduced in June through a smaller allocation to long bonds.
Weaker Canadian economic data are also expected to place downward pressure on the Canadian dollar relative to the U.S. dollar. The Fund actively manages this exposure. Following profit-taking, the long U.S. dollar position was closed, and the team is seeking to re-establish the position opportunistically at more attractive levels.
Given deeply oversold conditions in the Canadian dollar, the Fund did not initiate foreign-exchange trades during June. Active trading in the long-bond position contributed 0.12% to performance, while price appreciation added 0.26%. Series F returned 0.38% for the month, trailing the S&P Sovereign Bond Canada Index by 0.09%. Relative underperformance primarily reflected modest bull steepening, as the two-year yield declined four basis points while the long-bond yield was broadly unchanged.
Performance for the Fund over Q2 was 1.74%. The benchmark returned 1.49%. YTD were ahead of the bench by 89bps.
Outlook
The effect of higher energy prices during Q2 is expected to continue weighing on Canadian household spending into Q3. Weak business investment and a soft housing market add further pressure to the growth outlook. As economic activity slows, the Bank of Canada may be compelled to reduce policy rates, supporting a flatter yield curve and creating capital appreciation potential for the Fund’s Canadian long-bond exposure.
One development obscured by the Middle East conflict is the two-year decline in crude oil prices that preceded the recent spike, reflecting persistent oversupply and improved energy efficiency.
As illustrated in the Chart of the Month on page 3, crude oil traded within a well-defined downward channel through 2024 and 2025 before the conflict disrupted the trend.
Chart of the Month
Crude Oil (West Texas Intermediate - WTI) Futures, Rolling Front Contract - Three-Year Weekly
Source: Bloomberg
The chart should not be interpreted as a forecast that crude oil prices cannot move higher. Geopolitical uncertainty is likely to keep volatility elevated.
However, if the conflict de-escalates and global supply chains continue to reduce their dependence on the Strait of Hormuz, structural downward pressure on crude oil could re-emerge. Combined with disinflationary forces and weak Canadian growth, this backdrop would be supportive of Canadian long bonds as yields decline.